Risk, Credit and Rising Prices

Last Modified: 10/23/07
First Published: 09/14/07
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The availability of credit is based on how risk is distributed throughout markets. When money is borrowed, the more ways risk is spread, the lower the probability that any one person or institution can be adversely affected.

When we look at the rise of consumer debt in America, one of the most obvious outcomes has been the increased use of credit to finance lifestyles, including education and housing. This credit availability and utilization is possible because of the increased sophistication in the way risk has been spread across financial markets.

An asset is not fundamentally worth more now then it was at any other period, but the ability of that asset to be converted into some type of mortgaged security that can be traded makes that asset potentially more useful, or valuable. But with all this sophistication in converting physical assets into products that allow more credit to exist comes the calculation of risk.

Risk is something that denies its own existence, because it is never logical, it's always the murky perception of individuals that look for what they want to determine. One cannot really judge if something is inherently risky, but from a point of view, it might be. People assume the awareness of risk when they believe they can either control or, at least understand what they are attempting. Both lenders and borrowers try to calculate risk, but for the most part they are attempting to calculate ability to pay, or their ability to handle potential payment delays.

One effect of the increased use of distributed risk is an increase in prices. Housing prices, university tuition, and health care have all been rising for years, far more than general inflation. Risk is a condition which assumes that as it is decreased, demand increases in direct proportion. As a greater amount of government-backed university loans has made tuition possible for many Americans, we have a commensurate rise in tuition. If more people have the ability to pay the tuition, that increases demand, and overall prices.

This is an example of a process, certainly happening in America, which raises the risk premium we all assume to simply live. As prices rise because of the availability of credit, creating a demand that may have not really existed, the distribution of wealth in America has skewed more dramatically away from the middle and lower classes.

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